Will Costco Buy Sam’s Club?

There is some chatter out there that Walmart Stores Inc. (NYSE: WMT) is planning to spin its Sam’s Club membership store off into a separate company. This raises some intriguing possibilities, including the possibility of an acquisition of Sam’s Club by Costco Wholesale (NASDAQ: COST).

Those of you who are paying attention know that Costco has been on a tear lately. America’s favorite club store saw its TTM revenue increase by over one billion over the 2014–2015 holiday season. Costco reported a TTM revenue of $114.49 billion in November 2014 that grew to $115.64 billion on Feb. 28, 2015.

Costco’s same sales increased by 7% in January, and shopper traffic increased by 5.8% indicating that the retail recovery has definitely reached its warehouse. Meanwhile Sam’s Club’s sales without fuel grew by just 1.6% in the 13 weeks that ended on Jan. 30, 2015, and .5% during the year that ended on Jan. 30, 2015.

The numbers show us why Walmart is thinking of dumping Sam’s Club; it is simply incapable of matching Costco’s stellar performance. Worse, there are some indications that Sam’s is starting to lose customers to aggressive retail giants like Kroger (NYSE: KR) and Amazon.com (NASDAQ: AMZN). Sam’s own figures indicate that fuel sales fell by -0.4% in the 13 weeks that ended on Jan. 30, 2015, and .1% over the year. One reason for this could be competition from Kroger, which operates around 2,000 filling stations and aggressively markets its loyalty card program that enables customers to collect points to save on gas.

What Will Become of Sam’s Club?

There are a number of things Walmart could do with Sam’s Club, including:

It could try to fix Sam’s Club and make it more like Costco by trying to appeal to Value Shoppers. Methods of doing this could be beefing up Sam’s Club private brands, closing stores in predominately lower income areas, or converting them into Walmarts and offering more business services.

It could simply shut Sam’s Club down and convert stores into Walmart supercenters like it did with Sam’s Club Canada. Doing so would cost Walmart the revenue that it gets from Sam’s membership fees.

It could spin Sam’s Club off into a separate company. The disadvantage to this is that Walmart would lose the membership fee revenue and the Sam’s Club real estate. One problem is that it is not clear if an independent Sam’s Club could do any better than Walmart because it would have to set up its own logistics network. Currently Sam’s and Walmart share logistics. It would cost quite a bit of money to put Sam’s Club into a position to stand on its own feet. Although, Sam’s did generate $56 billion in revenue in 2012.

Walmart could sell all or part of Sam’s Club’s operations. The advantage to this would be that Walmart could get cash it could use to build up some of its other operations, such as Walmart.com and the Neighborhood Markets. The disadvantage would be that Walmart could deliver some potentially valuable assets to a competitor.

Would Costco Acquire Sam’s Club?

A logical suitor for Sam’s Club’s operations would be Costco. Sam’s Club and Costco share the same basic business model and compete for many of the same customers. Buying Sam’s Club would also give Costco access to many new markets; for example, Sam’s Club operates two warehouses in the City and County of Denver, where there is no Costco.

The biggest attraction for Costco at Sam’s Club would be its 47 million members. That could give Costco a huge boost to its float. It would also help Costco expand into areas like the South and the Midwest and to further tap the lucrative and growing small business market.

There would be some difficulties for such an acquisition because Costco and Sam’s target different customers. Sam’s caters to lower middle class customers, while Costco directs its sales to the upper middle class. Motley Fool writer Eshna Basu pointed out that 41% of Costco stores are located in America’s 10 richest states, while only 15.8% of Sam’s Clubs are located in the same states.

Another potential problem would be the Federal Trade Commission, or FTC, which would have to prove such an acquisition. It is obviously impossible to predict what federal regulators would do, but it is likely they would object to Costco getting a monopoly in the club store business like it has in Canada.

The possibility of a Costco acquisition might be one reason why Walmart will not spin Sam’s Club off. The last thing Walmart wants is for Costco to start opening up in new markets and replicating its success.

My prediction is that Walmart will keep Sam’s Club and try to fix it. Walmart needs to make Sam’s Club work if it wants to preserve its position as America’s number one retailer.

The author owns shares of Kroger (KR) and is a long time Sam’s Club member.